Abstract

When entering a monetary union, member countries change the nature of their sovereign
debt in a fundamental way, i.e. they cease to have control over the currency in which their
debt is issued. As a result, financial markets can force these countries’ sovereigns into
default. In this sense, member countries of a monetary union are downgraded to the status of
emerging economies. This makes the monetary union fragile and vulnerable to changing
market sentiments. It also makes it possible that self-fulfilling multiple equilibria arise.
This paper analyzes the implications of this fragility for the governance of the eurozone. It
concludes that the new governance structure – the European Stability Mechanism (ESM),
which is intended to be successor starting in 2013 of the European Financial Stability
Mechanism (EFSF), created in May 2010 – does not sufficiently recognize this fragility. Some
of the features of the new financial assistance are likely to increase this fragility. In addition,
it is also likely to present member countries from using the automatic stabilizers during a
recession. This is surely a step backward in the long history of social progress in Europe. The
author concludes by suggesting a different approach for dealing with these problems.